Scrutinize tax breaks and low-cost loans before making a capital commitment
The lingering recession has forced many business owners to find creative ways to generate revenue and decrease expenses. Fiscal and monetary policies intended to combat the recession have resulted in tax breaks and record-low interest rates. Many businesses will need to take advantage of these tax incentives and low-cost funds to survive the next several years. The trick is to make sure you use this money to increase your top line or decrease expenses instead of expanding your business until you run out of cash.
Borrow wisely
Just because the small business loan or tax incentive is available does not mean you need to or should take advantage of it. These programs are intended to increase spending by small businesses in order to spur the economy, but the last thing you need to do is spend your business into the ground.
Unless you correctly analyze the numbers, you may end up increasing your spending when your original intent was to decrease expenses. One of the best examples of this is the automobile industry's response to increased gas prices. Many car dealerships ran ads suggesting that you trade in your gas guzzler for a new vehicle that got better gas mileage. The premise was that you would save money by driving a more fuel-efficient car. Unfortunately, very few people calculated the full cost of buying a new car before they traded in their older vehicle. Yes, one component of the new car was less expensive (gasoline), but many other costs (insurance, car payment, annual excise tax) increased. In many cases, the desire to own a more fuel-efficient vehicle in order to save at the pump ended up costing more.
Do this same type of analysis before you decide to buy a new piece of equipment. The new equipment may be more efficient or have more bells and whistles than your existing machine, but you need to make sure the efficiencies increase revenue or decrease expenses enough to cover the equipment loan. You don't want to end up with a new piece of equipment that decreases your expenses by $400 a month but has a monthly payment of $600 a month.
Evaluate the true cost of new revenue models
Many business owners are looking for new revenue opportunities to increase their top line. Do the in-depth financial analysis to make sure your great new revenue idea will help your business rather than hurt it. The following questions can help you decide if a new venture will add to the top line or detract from the bottom line:
- Are your revenue streams achievable? We can all conjure up great-looking revenue numbers, but detailed analysis can help you determine if this revenue is achievable. For example, you may think your new venture selling widgets will generate gross income of $100,000 the first year. If each widget sells for $10 each, you need to be confident that you can sell a total of 10,000 widgets a year, or almost 1,000 a month.
- Carefully evaluate the cost of creating your new product. Make sure you include ALL costs in your analysis — increased utilities, insurance, maintenance, etc. — so your anticipated profits don't evaporate. You want to know if the widget-making machine with a fully-loaded cost of $98,000 a year will make widgets that sell for $100,000 a year. Understanding the difference between revenue and total cost can help you avoid the trap of "the more you make, the more you lose."
Fully analyze potential tax incentives
Tax incentives were created for a reason — to encourage business owners to purchase equipment and other capital items. Just because the government offers an incentive doesn't mean you should take advantage of it. Increased depreciation means a faster write-off of expenses, but it also means a cash outflow to buy the equipment. Think back to the "cash for clunkers" incentive a few years ago. Many people took advantage of this government program to get rid of their old cars and buy a new one. The end result for many people was a higher monthly car payment.
Look at the multi-year impact of any tax incentive program before you take advantage of it. While many tax incentives positively impact your bottom line, you also want to review the impact it will have to your cash flow. Accelerated depreciation increases expenses and decreases net income, so it can help decrease your tax bill. However, you need to know how your cash position is impacted by the purchase of a capital item. It makes no sense to buy an unnecessary piece of equipment just because of a tax incentive.
Carefully analyze decisions you make based on low-interest rate loans and tax incentives. Prudent use of these tools can help increase the net income and cash flow of your business. Not only will that help you, but it will also help move us out of the recession, one small business at a time.
Alison Hinson, owner of Alison Hinson MBA LLC, can be reached at alison@alisonhinsonMBA.com. Read more Profit Motives at here.
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